Britain faces an 'explosive debt trajectory' in the next 50 years if it ends austerity

REUTERS/Patrick T. Fallon
LONDON — Britain could face an "explosive debt trajectory" in the long term if it does not deal with its budgetary issues and reduce the deficit in a well thought out manner, according to research from the UK economics team at Bank of America Merrill Lynch.

Writing in a note circulated to clients on Tuesday, Robert Wood and Sebastian Cross argue that Britain is unlikely to see a great deal of fiscal expansion during the current parliament — as some have speculated — simply because the government, and particularly Chancellor Philip Hammond, are still concerned by the level of the UK's deficit. The deficit is essentially the gap between government spending and tax revenues.

"We think the Chancellor faces constraints that will prevent a wholesale repudiation of 'austerity'. More likely to our mind are small measures and repeated 'accidental' overshooting of deficit targets," the note argues.

Part of the problem, Bank of America's team argues, is that Hammond is well aware of the challenges the British economy faces on a horizon long beyond when he and Theresa May will be in power. "One reason to expect the Chancellor's current public resistance to easing austerity to continue are the long-term challenges facing the UK," Wood and Cross write.

"The aging population should push up government borrowing from the early-2020s unless the government continues austerity. Cutting migration won't help either. So what do we expect? A high-profile spending commitment partly funded by tax rises. In other words, talk of easing austerity but less action."

With Brits getting older and older, the government will be forced to spend more on social care, and generally have to fund its spending for longer periods as people live longer. That means an increase in borrowing, unless long-term austerity is imposed.

BAML's team cites work by the independent Office for Budget Responsibility, which shows that deficit could rise as a percentage of GDP to 1.8% in 2025, up from 0.7% in 2021 "if tax thresholds and working age benefits are raised in line with earnings rather than inflation "so receipts are not on an ever-rising path relative to GDP" and departmental spending rises in line with demographic pressures."

"In any case," the pair continues, "the rise in the deficit by 2025/26 absent austerity is just the start of a likely long-run trend. Absent action by the government the OBR sees UK debt to GDP ratio rising to 150% of GDP by the middle of the century (Chart 2)."

Below is chart 2, documenting the potentially explosive path of Britain's public sector borrowing over the next 50 years:

Bank of America Merrill Lynch

Britain is currently around the 20th most indebted country in the world in terms of debt-to-GDP ratio. If the figures presented in the chart above prove correct — and assuming other countries don't see their burdens increase on a similar trajectory to the UK, Britain could be one of the world's most in debt nations.